You owe it to yourself

Commentary: Focus on paying off credit-card debt, not credit scores

BOSTON (MarketWatch) -- With the government changing its rules about credit cards, the card issuers are changing the terms of their agreements with consumers. But consumers aren't changing a thing.

As a result, they're suffering through bad deals because they fear what might happen to their credit score if they try to stand up for themselves and be a smart customer.

"Consumers have a tendency to focus on the nuances of credit scoring and often lose sight of the bigger picture," said Greg McBride, senior financial analyst at BankRate.com.

"They are so worried about something hurting their credit score -- particularly in an environment like this one where lenders are tightening up and making it harder to qualify -- that they are willing to live with bad terms that they never would have agreed to in the first place," he added.

The Credit Card Accountability, Responsibility and Disclosure Act (widely known as the Credit CARD Act) takes effect in February, although a few key provisions kick in at the start of August. One of the key provisions that begins in August requires credit-card issuers to give 45 days' notice before any rate hike.

Rate hikes

As a result, many card issuers are tinkering with rates now, to get in under the wire, leaving consumers struggling with how to properly respond. No one wants to accept a rate hike, but they fear being cut off from available credit, even if their credit score is good. As the lending industry has tried to recover from its past excesses, it has lowered credit limits, closed accounts and tightened up lending standards, even to many of its best customers.

In effect, these consumers are protecting their credit score over their pocketbook, a move that might make sense if there's a need for a mortgage or car loan or other big-ticket, financed item in the next eight- to 12 months, but which is costly for anyone whose situation is stable.

McBride noted that many card issuers who are putting through a rate hike will allow a consumer to opt out of the higher costs, allowing them to pay off the bill under the old terms, but will close out the account.

"Too often, I have heard consumers come at this from the angle of how it impacts their credit score rather than the angle of 'How much money can I save in interest charges and how quickly can I pay off the debt?'" McBride said.

"Somebody who is looking at an interest-rate hike where their rate is going, say, from 10% to 18%, they could easily save themselves $1,000 in interest if they have a balance of several thousand dollars," he added. "Their best move is keeping the lower rate, letting the account close and paying off the debt, which will in turn help them get another credit card if they need it."

Keeping score

Credit scores are a strange and flexible thing. Frequently, something that a consumer would consider a good and smart move has negative short-term consequences to their score.

The average household credit-card debt is about $9,000; to keep things simple, let's say Joe Consumer has that debt spread over 10 cards -- including a couple of department-store credit cards, gasoline cards and general-purpose cards - each with a credit limit of $5,000. Getting rid of old, unused cards would seem to be a smart thing, as it would reduce the overall amount of credit the customer has access to; but if Joe drops two cards, he is now carrying the $9,000 in debt with just $40,000 in total available credit. That means he is closer to borrowing to his limit, which will drop his credit score.

Conversely, it seems negative when a consumer adds a new account, especially if they transfer a balance that runs it right up near the limit. Continuing the last example, say Joe Consumer didn't cancel anything, but instead added two new cards, making balance transfers to run each of the new cards up near their $5,000 limit. That's a negative; but over time, Joe's debt -- still $9,000 but now based on $60,000 of available credit -- will more than cancel that out to the good side.

And while the scoring system is confusing, so too is the area of what makes a "good" score. Prior to the current economic troubles, scores of 680-720 fell into the borderline area. Today, that gray area covers scores of 700-740 -- up to 760 for some lenders -- a score in that range will put you on bad terms with some lenders.

Consumers with scores below 700 may have to scramble to get credit, and may be forced to settle for lesser deals. People with high scores above 740 are in the driver's seat, even though they have not been immune to limit reductions, card closings and rate hikes.

"If you are going to get a mortgage, you may want to sit tight until the mortgage closes, but if you are not in the market for a mortgage right now, then you should try to minimize your costs and shift your balances to lower-rate products, rather than taking only what your current lenders give you," said Gerri Detweiler, co-author of "Debt Collection Answers: How to Use Debt Collection Laws to Protect Your Rights."

"It is possible to get new cards and deals right now," she added. "In fact, if you don't have a back-up card right now, I would recommend that you go to get one, so that if the credit cards you are relying upon do something you don't like, you have negotiating leverage or the ability to go elsewhere."

Even with new-card offers, experts suggest that consumers use extreme caution. Most credit-card lenders have removed the caps on their balance-transfer offers, meaning they charge a flat percentage of the amount being moved. BankRate released a study this week showing the average fee to be 3%, which means $30 for every $1,000 moved, a cost so high that it may eat up months or years of interest savings. The new law puts no limit on balance-transfer charges.

"What's important is that you don't just focus on your credit score, but you look at it in real dollars," Detweiler said. "Some people are so busy protecting their credit score that they are losing money to do it, and the savings could also help their bottom line, which would in turn help their credit score over time."

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